Your assignment is worth 6 pts, and each of the questions
Your assignment is worth 6 pts, and each of the questions
Your assignment is worth 6 pts, and each of the questions must have at least ahalf of page of writingsupported by more than the textbook refererence, it must come from the FNU Library. In addition your answers must prescribe to APA format.. You must submit a cover page, each question in a page by itself, and your references page must be also in a page by itself. And, please do not forget to reference your in-text. Lastly your assignment must be submitted via “Safeassign” in order to obtain your max points your work must be original in at least 70%.
Answer the following questions:
– Explain the effect of an increase in consumer income on the demand for a good.
– In your own words, explain the logic of the income-expenditure model. What determines the amount of real GDP demanded?
– Define the economy’s potential output. What factors help determine potential output?
Demand, Wants, and Needs
Consumer demand and consumer wants are not the same. As we have seen, wants are unlimited. You may want a new Mercedes-Benz SL65 Roadster convertible, but the $215,250 price tag is likely beyond your budget (that is, the quantity you demand at that price is zero). Nor is demand the same as need. You may need a new muffler for your car, but a price of $300 is just too high for you right now. If, however, the price drops enough—say, to $200—then you may be both willing and able to buy one.
Substitution Effect of a Price Change
What explains the law of demand? Why, for example, does the quantity demanded in- crease as the price declines? The explanation begins with unlimited wants confronting scarce resources. Many goods and services can help satisfy particular wants. For ex- ample, you can satisfy your hunger with pizza, tacos, burgers, chicken, or hundreds of other foods. Similarly, you can satisfy your desire for warmth in the winter with warm clothing, a home-heating system, a trip to Hawaii, or in many other ways. Clearly, some alternatives are more appealing than others (a trip to Hawaii is more fun than warm clothing). In a world without scarcity, everything would be free, so you would always choose the most attractive alternative. Scarcity, however, is the reality, and the degree of scarcity of one good relative to another helps determine each good’s relative price. Notice that the definition of demand includes the other-things-constant assumption. Among the “other things” assumed to remain constant are the prices of other goods. For example, if the price of pizza declines while other prices remain constant, pizza be- comes relatively cheaper. Consumers are more willing to purchase pizza when its rela- tive price falls; they substitute pizza for other goods. This idea is called the substitution effect of a price change. On the other hand, an increase in the price of pizza, other things constant, increases the opportunity cost of pizza—that is, the amount of other goods you must give up to buy pizza. This higher opportunity cost causes some consumers to substitute other goods for the now higher-priced pizza, thus reducing their quantity of pizza demanded. Remember that it is the change in the relative price—the price of one good relative to the prices of other goods—that causes the substitution effect. If all prices changed by the same percentage, there would be no change in relative prices and no substitution effect.
Income Effect of a Price Change
A fall in the price of a good increases the quantity demanded for a second reason. Suppose you earn $30 aer of dollars received per period, in this case, $30 per week. Suppose you spend all that on pizza, buying three a week at $10 each. What if the price drops to $6? At that lower price, you can now afford five pizzas a week. Your money income remains at $30 per week, but the price drop increases your real income—that is, your income measured by what it can buy. The price reduc- tion, other things constant, increases the purchasing power of your income, thereby increasing your ability to buy pizza. The quantity you demand will likely increase be- cause of the income effect of a price change. You may not increase your quantity de- manded to five pizzas, but you could. If you decide to purchase four pizzas a week when the price drops to $6, you would still have $6 remaining to buy other stuff. Thus, the income effect of a lower price increases your real income and thereby in- creases your ability to buy pizza and other goods, making you better off. The income effect is reflected in Walmart’s slogan, which trumpets low prices: “Save money. Live better.” Because of the income effect, consumers typically increase their quantity demanded when the price declines.
Conversely, an increase in the price of pizza, other things constant, reduces real income, thereby reducing your ability to buy pizza and other goods. Because of the income effect, consumers typically reduce their quantity demanded when the price in- creases. The more important the item is as a share of your budget, the bigger the income effect. That’s why, for example, consumers cut back on a variety of purchases when the price of gasoline spikes, as it did in 2012. And that’s why consumers increase a variety of purchases when the price of gasoline plunges, as it did in late 2014 and early 2015. Again, note that money income, not real income, is assumed to remain constant along a demand curve. Because a change in price changes your real income, real income varies along a demand curve. The lower the price, the greater your real income.
4-2a Consumer Income
Exhibit 2 shows the market demand curve D for pizza. This demand curve assumes a given money income. Suppose consumer income increases. Some consumers are then willing and able to buy more pizza at each price, so market demand increases. The de- mand curve shifts to the right from D to D9. For example, at a price of $12, the amount of pizza demanded increases from 14 million to 20 million per week, as indicated by the movement from point b on demand curve D to point f on demand curve D9. In short, an increase in demand—that is, a rightward shift of the demand curve—means that consumers are willing and able to buy more pizza at each price. Goods are classified into two broad categories, depending on how consumers respond to changes in money income. The demand for a normal good increases as money income increases. Because pizza is a normal good, its demand curve shifts rightward when money income increases. Most goods are normal. In contrast, demand for an inferior good actually decreases as money income increases, so the demand curve shifts leftward. Examples of inferior goods include bologna sandwiches, used furniture, and used clothes. As money income increases, consumers tend to switch from these inferior goods to normal goods (such as roast beef sandwiches, new furniture, and new clothes)
-2b Prices of Other Goods
Again, the prices of other goods are assumed to remain constant along a given demand curve. Now let’s bring these other prices into play. Consumers have various ways of trying to satisfy any particular want. Consumers choose among substitutes based on relative prices. For example, pizza and tacos are substitutes, though not perfect ones. An increase in the price of tacos, other things constant, reduces the quantity of tacos demanded along a given taco demand curve. An increase in the price of tacos also increases the demand for pizza, shifting the demand curve for pizza to the right. Two goods are considered substitutes if an increase in the price of one shifts the demand for the other rightward. Goods used in combination are called complements. Examples include Pepsi and pizza, milk and cookies, hot dogs and hot-dog buns, cars and gasoline, computer software and hardware, and airline tickets and rental cars. Two goods are considered complements if an increase in the price of one decreases the demand for the other, shift- ing that demand curve leftward. For example, an increase in the price of Pepsi shifts the demand curve for pizza leftward. But most pairs of goods selected at random are un- related—for example, pizza and housing, or milk and gasoline. Still, an increase in the price of an unrelated good reduces the consumers’ real income and can thereby reduce the demand for pizza and other goods. For example, a sharp increase in housing prices reduces the income left over for other goods, such as pizza.
4-2c Consumer Expectations
Another factor assumed constant along a given demand curve is consumer expectations about factors that influence demand, such as incomes or prices. A change in consumers’ income expectations can shift the demand curve. For example, a consumer who learns about a pay raise might increase demand well before the raise takes effect. A college senior who lands that first full-time job may buy a new car even before graduation. Likewise, a change in consumers’ price expectations can shift the demand curve. For example, if you expect the price of pizza to jump next week, you may buy an extra one today for the freezer, shifting this week’s demand for pizza rightward. Or if people come to believe that home prices will climb next year, some will increase their demand for housing now, shifting this year’s demand for housing rightward. The expectation of lower prices has the opposite effect. For example, during the recession of 2007–2009, people expected home prices to continue falling, so they put off buying homes, shifting the demand for housing leftward. Such expectations can often be self-fulfilling.
4-2d Number or Composition of Consumers
As mentioned earlier, the market demand curve is the sum of the individual demand curves of all consumers in the market. If the number of consumers changes, the demand curve will shift. For example, if the population grows, the demand curve for pizza will shift rightward. Even if total population remains unchanged, demand could shift with a change in the composition of the population. For example, an increase over time in teenagers as a share of the population could shift pizza demand rightward. A baby boom would shift rightward the demand for car seats and baby food. A growing Latino population would affect the demand for Latino foods.
4-2e Consumer Tastes
Do you like anchovies on your pizza? How about sauerkraut on your hot dogs? Are you into tattoos and body piercings? Is music to your ears more likely to be rock, country, hip- hop, reggae, R&B, jazz, funk, Latin, gospel, new age, or classical? Choices in food, body art, music, sports, clothing, books, movies, TV shows—indeed, all consumer choices—are influenced by consumer tastes. Tastes are nothing more than your likes and dislikes as a consumer. What determines tastes? Your desires for food when hungry and drink when thirsty are largely biological. So too is your desire for comfort, rest, shelter, friendship, love, status, personal safety, and a pleasant environment. Your family background affects some of your tastes—your taste in food, for example, has been shaped by years of home cooking. Other influences include the surrounding culture, peer pressure, and religious convictions. So economists can say a little about the origin of tastes, but they claim no special expertise in understanding how tastes develop and change over time. Economists recognize, however, that tastes have an important impact on demand. For example, al- though pizza is popular, some people just don’t like it and those who are lactose intoler- ant can’t stomach the cheese topping. Thus, most people like pizza but some don’t. In our analysis of consumer demand, we will assume that tastes are given and are relatively stable. Tastes are assumed to remain constant along a given demand curve. A change in the tastes for a particular good would shift that good’s demand curve. For example, a discovery that the tomato sauce and cheese combination on pizza promotes overall health could change consumer tastes, shifting the demand curve for pizza to the right. But because a change in tastes is so difficult to isolate from changes in other de- terminants of demand, we should be reluctant to attribute a shift of the demand curve to a change in tastes. We therefore try to rule out other possible reasons for a shift of the demand curve before accepting a change in tastes as the explanation. That wraps up our look at changes in demand. Before we turn to supply, you should remember the distinction between a movement along a given demand curve and a shift of a demand curve. A change in price, other things constant, causes a movement along a demand curve, changing the quantity demanded. A change in one of the determinants of demand other than price causes a shift of a demand curve, changing demand.
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